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Monitor Ventures Inc (TSXV:MVI) is trading with a trailing P/E of 7.3x, which is lower than the industry average of 20.3x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for Monitor Ventures
Demystifying the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. By comparing a stock’s price per share to its earnings per share, we are able to see how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for MVI
Price-Earnings Ratio = Price per share ÷ Earnings per share
MVI Price-Earnings Ratio = CA$0.22 ÷ CA$0.03 = 7.3x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as MVI, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. Since MVI’s P/E of 7.3x is lower than its industry peers (20.3x), it means that investors are paying less than they should for each dollar of MVI’s earnings. As such, our analysis shows that MVI represents an under-priced stock.
A few caveats
Before you jump to the conclusion that MVI is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to MVI. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with MVI, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing MVI to are fairly valued by the market. If this does not hold true, MVI’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to MVI. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I urge you to complete your research by taking a look at the following: